Saturday, February 28, 2009

Chart of the Week: GDP Worse Than Expected

A lot happened in the markets this week: the government took a larger ownership stake in Citigroup (C); blue chip stalwarts JPMorgan Chase (JPM) and General Electric (GE) both slashed their dividends; durable goods and housing data failed to meet already lowered expectations; Q4 GDP was revised down to a 6.2% annualized drop; and the S&P 500 index fell to levels not seen since 1996.

In spite of all these body blows, the markets held up reasonably well, with the exception of the GDP data, which delivered a knockout blow Friday morning. The GDP numbers are notoriously backward-looking and the revisions to advance GDP data lend very little to the existing body of economic knowledge. That being said, Friday’s GDP numbers touched a statistical and psychological nerve for a market that was just not prepared to digest another assessment of how sharp the economic fall has been.

This week’s chart of the week attempts to put the most recent GDP number in historical perspective. While not shown on the chart, the raw GDP for the fourth quarter of 2008 is at approximately the level of economic activity that prevailed in June 2007. Also, while the 6.2% (annualized) drop in Q4 GDP is quite concerning, it is less than what we saw in the first quarter of 1982 (-6.4%) and the second quarter of 1980 (-7.8%). Going back even further (and not shown on the chart), GDP dropped a whopping 10.4% in the first quarter of 1958.

I have added a dashed blue line to show a four quarter moving average of GDP. By this measure, the current situation still has a way to go before it compares to 1991, not to mention the even larger four quarter dips in the 1970s and 1980s referenced above.

A survey of 43 economic forecasters published two weeks ago by the Federal Reserve Bank of Philadelphia showed expectations for a 5.2% drop in Q1 2009 GDP, followed by a 1.8% drop in Q2. Given the most recent revisions to the Q4 data, a 5.2% drop in the current quarter may be on the optimistic side, but the burning question right now is whether Q3 can show any growth at all – or at least a decrease in the rate of economic deterioration.

[source: Bureau of Economic Analysis, VIXandMore]

Friday, February 27, 2009

Volatility Storm at Two Years and Counting…

It was exactly two years ago today that the first winds of the volatility storm blew in from China. Back on February 27, 2007, concerns about the Chinese government raising interest rates to discourage speculation helped to trigger an 8.8% loss in the Shanghai Composite Index and a 9.9% loss in the FTSE/Xinhua China 25 index that is the basis for the popular Chinese ETF, FXI.

In one of the earlier challenges to the decoupling theory, stocks around the world fell in sympathy, with the Dow Jones Industrial Average losing 416 points later that day to close at 12,216. The simultaneous 64% spike in the VIX still stands as a one day record, though two years later it seems a little quaint to talk about a massive VIX spike when the VIX failed to get out of the teens.

As the chart below shows, following the February VIX spike, the floor in the VIX jumped from 10.00 to 12.00 and that floor kept rising, first to 15, then 16, 18 and 22. In fact, the pattern of higher lows continued for over a year.

In the StockCharts chart, I have elected to show volatility as an area chart to emphasize the rising tide aspect of volatility. Even though the May 2008 bottom prints as a lower low and the IndyMac Bank failure in July shows up as a lower high, this turned out to be the last glimpse of somewhat normal volatility before September 2008 unleashed the full force of the volatility storm. For easy reference and archival purposes, I have highlighted a handful of fundamental events that coincided with some of the important tops in the VIX in the past two years.

It has now been two full years and counting since the big drop in China and the first global volatility ripples, yet only a few hearty souls are willing to go out on a limb and predict that the worst is behind us.

Frankly, it think it is unlikely – though certainly not out of the realm of possibility – that we will see the VIX close over 80 again during the next decade, but then again two years ago no one was predicting that it would be so easy to keep the VIX above the 40 level for five full months.

This storm will eventually blow itself out, but the coastline will never look the same again.

[source: StockCharts]

Thursday, February 26, 2009

Recent Acorda Therapeutics Rumors

Rumors are a part of Wall Street. They always have been and they always will be.

For the most part I tend to ignore the rumors and not bother to mention them on the blog, but occasionally one is too interesting to pass up or illustrates a point I would like to make. With Acorda Therapeutics (ACOR) it is a matter of both.

The fun began on Acorda’s conference call (transcript courtesy of Seeking Alpha) on Tuesday, when President and CEO Ron Cohen found himself fielding quite a few questions about potential European partnerships for Fampridine-SR and about the path forward in the U.S. market. Cohen summarized his thinking on the subject as follows:

“From our perspective, the bar is extremely high to allow anyone to co-promote in the US with us. Obviously everything has a price and we’re going to be guided by what we think optimizes the value of the asset, but from our perspective right now, the very much most likely way to optimize the value in the US is for us to do that, and to commercialize it ourselves; whereas ex-US, the opposite obtains.

We think that depending on the nature of the deal we could do, it’s likely that partnering would be a more effective way to go, but again, that’s an outlook. It really depends on what sort of offers people make and we have to assess those on a as they come basis.”

Things got interesting after the conference call when a rumor appeared that Biogen Idec (BIIB) was in talks with Acorda and that an acquisition was one of the possible outcomes. This rumor helped to send Acorda stock up 19% on Tuesday on heavy volume. Yesterday Biogen Idec apparently denied the discussions with Acorda and Acorda’s stock gave back 5.5%. Today there are rumors of a possible Biogen Idec takeover of Acorda, with a price tag as high as $40 per share being floated, which is about a 70% premium over where Acorda is trading today.

With all the rumors, Acorda is down another 2% today and skeptics of the deal abound.

With all this speculation, one of my favorite sources for getting a handle on the options activity is Specifically, I like to look at the WhatsTrading 10 day chart of put and call activity, which I have reproduced below. In the chart, it is clear that Tuesday’s activity triggered more activity in puts than calls. Over the course of the past two days, however, volumes have been ramping up in the calls. The data is by no means conclusive, but at current levels, with the stock having given back a fair portion of Tuesday’s gains and implied volatility tracking only slightly above the average for the past four months, this has become an interesting long call play.


Disclosure: Long ACOR at time of writing.

(For those who may be interested, recently began offering some premium options services)

Wednesday, February 25, 2009

Mini-VIX Futures Coming on March 2nd

The CBOE is out with a press release confirming that mini-VIX futures will begin trading next Monday.

The mini-VIX is 1/10 the size of the standard VIX futures contract, making the mini-VIX much more approachable for the typical retail investor.

VXX Juice Factor and Portfolio Insurance Implications

While I continue to receive quite a few questions about VXX, the new the VIX ETN, I note that volume seems to have settled into a pattern of approximately 100,000 shares per day. Perhaps the interest in this product is going to be more of an academic nature in the early stages, before trading and hedging strategies become better developed.

In any event, one of the key issues surrounding VXX has to do with what I call the VXX juice factor. In a nutshell, the question surrounds what sort of movement one can expect from a long VXX position relative to the VIX. Another way of looking at the same issue is to phrase the question in terms of how much VXX will move in one direction when the SPX moves in the opposite direction.

Last Friday, in VXX Tracking VIX at 80+% Today, I attempted to answer the first of these questions based on historical data. Today I will take a shot at both questions, using data from the first 17 days since the launch of VXX and with the aid of the graphic below.

In the first 17 days it has traded, I show VXX with a juice factor of just under 70%, meaning that, on average, for every 1% movement in the VIX, VXX has moved about 0.7%. Unfortunately, when the VIX makes a large move, this is the time when VXX typically has the smallest juice factor, as the divergences on February 12th and February 17th demonstrate.

At this stage, my working hypothesis is that VXX provides the most portfolio insurance when you don’t need it at all and is least effective when you need it the most.

I will address this issue in more detail going forward and bring some more data to bear on the subject.

[source: VIXandMore]

Tuesday, February 24, 2009

Germany and China Faring Relatively Well in Downturn

With the SPX perched precariously above its November low and pundits monitoring the vital signs around the clock, coverage of the stock markets in the U.S. has once again taken on a very Americentric tone. For the most part, focusing on the U.S. financial system and the U.S. economy makes sense. One of the many lessons to come out of the current financial crisis, however, is the end of the decoupling myth. In fact, we are all butterflies flapping our wings on a global stage now.

As always, some countries are faring better than others. The chart of the Nikkei 225 looks sufficiently like that of the SPX that I elected to omit it from the graphic below. Instead, I have chosen to compare the stock market indices of the world’s third and fourth largest economies, China (FXT, the index that forms the basis of the popular ETF, FXI) and Germany (DAX), in the context of the S&P 500 and the Dow Jones World Stock Index (DJW).

Note that relative to the October/November lows, China has shown a distinct pattern of making higher lows – in sharp contrast to U.S. and global indices. Germany has also shown considerable resiliency. Even though the DAX is now trading below its November low, Germany stocks have outperformed their global counterparts.

Scrolling back to 2003, I find it interesting that both China and Germany still are well above their 2003 lows, while the Dow Jones World Stock Index is now only about 5% above the lows from that bear market.

So while most investors are currently focusing their attention on the Dow Jones Industrial Average, the S&P 500, the NASDAQ indices and the Russell 2000, support levels and trends in key international indices may hold equally important clues about global buying and selling patterns – and the possibility of finding a bottom.

[source: StockCharts]

Monday, February 23, 2009

VIX Kitchen Sink Chart

The VIX is once again above 50 as I type this and technical analysis aficionados are wondering where the next resistance levels are for the VIX and whether these might increase the odds of predicting a market bottom.

The chart below is a kitchen sink chart of sorts, as it includes the 10 day moving average of the VIX (dotted blue line), surrounded by 10% moving average envelopes (solid blue lines) to indicate when the VIX is 10% above or below that 10 day moving average.

The chart also includes Bollinger Bands (the gray cloud around the price history), which have been left at the default 20 day, 2.0 standard deviations settings. I have also added the %b setting for the Bollinger Bands in order to determine where the VIX is relative to the middle (0.5) of the Bollinger Band range.

During highly volatile periods, the Bollinger Bands are typically much wider than the moving average envelopes and large moves in the VIX usually pierce the moving average envelopes before they reach the limits of the Bollinger Bands. At present, however, the upper boundary of the Bollinger Bands is at 50.36, with the top of the moving average envelope at 50.91. With the VIX having posted an intraday high of 50.70 so far, the Bollinger Bands have been violated, yet the moving average envelope is intact. This unusual situation reflects the relatively low historical volatility we have been experiencing (the 20 day historical volatility in the SPX is below 35 and 50 day historical volatility in the SPX is the lowest it has been since September.)

If one considers that implied volatility is largely a function of historical volatility plus a premium based on fear and uncertainty, then obviously the fear and uncertainty component is currently responsible for implied volatility (in the form of the VIX) being almost 50% higher than historical volatility.


Saturday, February 21, 2009

Chart of the Week: How Much Citigroup for My Gold?

In 2001, an investor who wanted to exchange his gold bullion for Citigroup (C) shares was able to acquire about six shares of stock for each ounce of gold. With Citigroup closing just under 2.00 yesterday and gold above the 1000.00 mark, that same swap now entitles the holder of gold to about 514 Citigroup shares.

The change in fortunes says much less about gold, which is almost 300% above the 2001 lows, than it does about Citigroup, which has fallen about 96% from an early 2007 high.

This week’s chart of the week chronicles the ratio of gold continuous contract futures to the price of Citigroup stock, essentially tracking the exchange rate for Citigroup in gold since the beginning of 2007. In many respects, this chart is also an excellent proxy for the magnitude of the problems facing the U.S. banking system.

[As an aside, now three months old, the full history of the VIX and More Chart of the Week series can be found by following the chart of the week link.]

[source: StockCharts]

Friday, February 20, 2009

Institutional Buying in VIX March 60 Calls

Jamie Tyrrell reports from the CBOE trading floor on OptionMONSTER’s Volatility Sonar report, discussing some interesting large VIX options trades, including institutional purchases of:

  • 4000 March 60 calls @ 1.40

  • March 55-65 call spread @ 1.25

VXX Tracking VIX at 80+% Today

As I write this, the VIX is at 51.30, up 9% and VXX is at 116.40, up 7.5%.

I continue to get quite a few questions about VXX, the VIX ETN. The biggest issues, by far, seem to be around how well VXX tracks the VIX and how much juice to expect from VXX relative to the VIX.

As best I can determine, when there are small day to day changes in the SPX, VXX should reflect, on average, approximately 35-40% of the daily change in the VIX. In more volatile markets, such as SPX daily changes of 3% or more, VXX should move, on average, about 55-60% as much as the VIX does. (Of course, on average, if you walk down the middle of a two way street you won’t get hit by oncoming traffic, but deviate to one side or the other even briefly…)

For more information on the movements of VXX and the VIX, check out Directional Exposure to Volatility Via Listed Futures: S&P 500 VIX Short-Term Futures Index, authored by Gareth Parker, Gerlinda Liu and Keith Loggie of Standard & Poors.

Global Bank Stocks in a Post-Lehman World

I get tired of talking about the banks, but it is the story for the foreseeable future. While Citigroup’s (C) common stock flirts with the 2.00 line (can we call it Bank of Mendoza?) and insists it has not had conversations with the government about nationalization, Bank of America (BAC), whose stock is barely above the 3.00 level, is also out saying, “We see no reason to nationalize a bank that is profitable, well capitalized and actively lending.” Add to the financial stew a Wells Fargo (WFC) stock under 10.00 for the first time since 1996 and it is hard not to be obsessed by the banking sector.

For all the discussion of U.S. banks, I wish to turn to the global scene. Lately U.K. banks and Irish banks have been the target of rumblings about possible nationalization, so I am going to skip over banks from these countries and instead focus on the largest banks in two critical European countries (Germany and Spain) and two critical Asian countries (Japan and South Korea). These four banks are Deutsche Bank (DB), Banco Santander (STD), Mitsibushi UFJ Financial (MTU) and Kookmin Bank (KB). All four banks happen to trade in the U.S. via American Depository Receipts (ADRs).

In the chart below, I have graphed the performance of all four giant banks since the last week in September, when the ripple effects of the Lehman bankruptcy and nationalization of AIG began to be felt across the globe. Not surprisingly, all four banks have seen their stock prices fall by more than 50%, with Deutsche Bank the worst performer among the group and Mitsibushi UFJ Financial feeling the least amount of pain. For comparison purposes, most of the Irish and British banks are down more than 90% during the same period.

The global banking crisis obviously has a long way to go before anyone can say with confidence that it is behind us. In the interim, even a medium-sized bank from a country most U.S. investors are not watching closely can lead to another tipping point that puts the global financial system closer to the brink. Investors seeking to keep a weather eye on global financial firms may also wish to monitor closely the iShares Global Financials ETF (IXG).

[source: BigCharts]

Thursday, February 19, 2009

Tell Congress to Block the Trader Tax

In case anyone missed this, I encourage you the read (and sign the petition to) Tell Congress to Block the Trader Tax

VIX Sluggish as Market Probes Lows

A reader asked why the VIX was down almost 5% with the SPX basically flat.

In addition the possibility of statistical white noise, there are several factors which may be affecting today’s VIX readings relative to the SPX. In no particular order, they include:

  • Much of the news cycle uncertainty is gone (earnings season is essentially over, Geithner made his speech about TARP 2.0, the FOMC minutes are out, almost all of the key economic data for February has been released, etc.)

  • Most of the recent volatility has been in the banks (KBE) and banks are an increasingly smaller portion of the S&P 500 index (two years ago financials (XLF) were 22% of the SPX, now they are only 10%)

  • VIX futures indicate expectations are for a VIX in the low 40s during the second half of the year

  • Low volatility leading into options expiration – while the SPX was down 4.6% on Tuesday, in four of the past five days the daily closing change has been no more than +/-1%

  • The VIX is significantly higher than the 10, 20, 30 and 50 day historical volatility in the SPX – all of which is currently under 40 (see below)

[source: VIXandMore]

Wednesday, February 18, 2009

Follow Up to “A VIX Butterfly Play”

Someone asked me to explain how the VIX options trade I outlined yesterday in A VIX Butterfly Play turned out. I will try to keep the explanation short.

The original trade, which I described yesterday morning when the VIX was trading at 50.04, was as follows:

  • long 10 VIX Feb 45 calls
  • short 20 VIX Feb 50 calls
  • long 10 VIX Feb 55 calls

To review, yesterday was the last trading day in VIX February options and today the VIX February contract exercise-settlement value was fixed at a special opening quotation (SOQ) of the VIX that was based off of the SPX March options series. Today’s SOQ (ticker VRO) was 48.40, which was 0.26 below yesterday's VIX close.

[Note that the reason the VIX has its own options expiration calendar is that VIX options settle 30 days prior to the options expiration date for SPX options in the subsequent month.]

To summarize, the profit zone for this trade was a VIX of 46.80 - 53.20, with the trade breaking even at the extremes of the range. The maximum profit was at a VIX of 50.00.

With a 10/20/10 position, the maximum potential profit for this trade was $3200; the maximum potential loss (with a VIX either at 45 or below or at 55 or above) was $1800. At 48.40, the VIX just happened to close exactly halfway between the maximum gain and the break even area. As a result, the trade gained half of the maximum potential profit, or $1600. Of course these profit and loss numbers are based on a position involving 40 calls (10/20/10). I consider that to be a 10 unit trade. With the accounting on an individual unit basis (long 1, short 2, long 1), the profit would have been $160 per unit.

In one sense, this type of trade is a pure gamble on volatility, but when volatility is unusually high, as it was last night, the profit zone can be large enough to make it a positive expectation trade, depending on one's forecast of overnight volatility.

US Bancorp Reeling

Not too long ago, Minneapolis-based US Bancorp (USB) was held up as an example as a ‘good bank’ with a strong loan portfolio. As recently as September, the stock was trading as high as 42 and the bank was widely hailed as one of the few national banks that was gaining ground on weaker competitors. On January 21, however, the bank announced a 65% drop in earnings as a result of a deteriorating loan portfolio and securities losses and the story began to unravel.

In reviewing the performance of bank stocks over the course of the past week, I was surprised to see that among large banks, US Bancorp has been the worst performer of all. The chart below shows the earnings-related 52-week low from January 21 was taken out decisively yesterday, following a week of heavy volume in which the stock lost a third of its value.

While investors are watching Citigroup (C) and Bank of America (BAC) closely for signs of weakness, perhaps US Bancorp and the regional banks are better indicators of what is going on in the banking landscape than their quasi-governmental big brothers.

[source: StockCharts]

Tuesday, February 17, 2009

Looks Like No EOD Buy Signal From VIX:VXV Ratio

At 3:45 p.m. ET the VIX:VXV ratio is at 1.051.

Now this ratio will continue to update until 4:15 p.m., but for those looking for a signal to get long during the regular trading session, it does not look like we will have one.

A VIX Butterfly Play

I usually shy away from generating trade ideas, but here is a gamble that I know at least one trader is sure to be taking today: a VIX pre-expiration butterfly.

The butterfly trade highlighted below is for illustrative purposes only, but should explain the approach. The idea is simple. This butterfly trade will make a profit if the special opening quotation (SOQ) for the VIX is between 46.80 and 53.20 – about 6.4% in either direction from the current VIX level of about 50. In other words, if the VIX falls in a 12.8% band around the current price, the trade makes money.

Of course a lot can happen with the VIX in less than a day, but in terms of trading, there are about 3 ½ hours left in today’s session. Before tomorrow’s open, there are several important economic reports, including January building permits and housing starts, as well as January industrial production and capacity utilization. If those reports don’t bring the end of the world any nearer than it is now – or indicate that all the economic problems are suddenly solved – then the VIX butterfly trade should be in good shape.

Note that the maximum loss is about 56% of the potential maximum gain, which will happen if the VIX SOQ is ‘pinned’ at 50 tomorrow morning.

[source: optionsXpress]

VIX:VXV Ratio Signals a Buy

The VIX:VXV ratio, which has been decidedly neutral for more than two months, is up over 1.08 (was at 1.10 earlier), signaling a buy.

Officially, this ratio does not generate a buy or sell signal until the end of the day, but on days like today, it is always nice to get an early warning signal.

If all hell does not break lose, I will revisit the VIX:VXV ratio just before the close and update the signal, if any.

VIX Spikes Over 50 as SPX Drops Below 800

VIX at 50.04 with SPX at 798.

The VIX hasn’t been over 50 since January 23rd.

It will be interesting to see what the SPX does for support today now that the 800 level is taken out.

Internally, the financials are the main culprit in the early going, as technology and small cap stocks have already started to rally.

Last Trading Day for VIX February Options. Try VXX Instead?

With Europe and European financial institutions under pressure this morning and the SPX futures down more than 3% about ten minutes before the open, investors will likely be looking for some portfolio protection in today’s session.

Normally, I would be thinking about VIX options here, but since today is the last trading day for February VIX options (which expire at the open tomorrow) and March options will not provide the same level of juice, this might be a good time to look at VXX, the short-term VIX ETN that is based on VIX futures.

VXX does not have much of a track record so far, but it has been moving at about 75% of the rate of the cash/spot VIX. If the SPX were to drop 3+% today, I would expect VXX to gain in the area of 10%.

Also, today should be a good day to see if VXX volume provides clues about market sentiment. Eventually, VXX volume peaks should provide some bullish contrarian sentiment clues, but it is too early to be able to get a good read on these as of yet.

[source: StockCharts]

Saturday, February 14, 2009

Chart of the Week: SPX Volatility on the Wane

In my chart of the week posts I have been striving for more of a generalist theme, with only occasional excursions into the land of volatility. I am making an exception this week, because for the first time in five months the historical volatility of the S&P 500 index (SPX) as measured by 10 day, 20 day, 30 day and 50 day look back periods is less than 40 in all four instances.

In the chart below, I have elected to show the fluctuations in the volatility of the SPX over the course of the past eight months as reflected in two Bollinger bands ranges. The outer range (gray) is the standard 20 day, 2 standard deviations measure. The inner range (blue) covers 20 days but only one standard deviation. The contraction of the Bollinger bands since the beginning of December and particularly in the first two weeks of February shows how volatility has been declining dramatically, notwithstanding the mid-January spike in the VIX. In fact, at current levels, the Bollinger bands are now as narrow as they have been since the week of the Lehman Brothers bankruptcy.

Given current trends, I would expect to see the VIX to be back in the 30s before the end of the month, with a VIX below 35 more likely than a VIX above 50.

Note: Those with an interest in learning more about Bollinger bands and/or customizing the settings on these indicators may wish to check out a series of posts from last June:

[source: StockCharts]

Friday, February 13, 2009

VXX and VIX Diverging

It has been an interesting week for volatility, with the VIX seemingly having a mind of its own and responding rather sluggishly to some of the major moves in the market. For the most part, VXX, the new VIX ETN, has been moving in concert with the VIX, if only at a rate of about 80% of the volatility index.

Today, however, marks the first significant divergence between VXX and the VIX since VXX started trading on January 30th. As I write this, VXX is down 0.84% for the day while the VIX is up 2.79% – a divergence which can be picked up in the ten day chart with hourly bars below.

I have no particular explanation for today’s divergence. For now at least, I merely wish to call attention to this phenomenon and keep an eye on it going forward.

[source: BigCharts]

Thursday, February 12, 2009

Regional Banks in Trouble

While the first six weeks of 2009 have seen pockets of bullishness in stocks, one sector that has been notably absent from the occasional bursts of buying activity has been financials. Within the financial sector, the weakest of the weak has been regional banks, which will see little in the way of benefits from TARP 2.0 and stand to lose a great deal if the consumer credit crisis continues to deepen, as almost everyone now expects will be the most likely scenario.

In the three month chart below, you can see that since the beginning of the year, the S&P 500 index has given up about half of the gains it has made since the November 21st bottom. The regional banks, on the other hand (represented here by KRE, an ETF), have fallen sharply below their November lows and are now even below the lower lows of January and early February.

There is little doubt that regional and local banks have huge fundamental challenges ahead of them. I have seen estimates that 10% or more may even fail before the economy can be nursed back to health.

If regional banks continue to reflect deteriorating valuations, I find it hard to believe that the broader market will be able to shake off this concern and manage a significant rally. At the very least, I would expect the market to be no better than range bound at least until the stocks of regional banks can be taken off of life support.

[source: BigCharts]

Wednesday, February 11, 2009

Thinking About Volatility (First in a Series)

Lately I have been fielding a large number of questions about historical volatility, implied volatility and a variety of related subjects. For this reason, it seems like a good time to kick off what I envision as a series of educational posts on the subject.

First I would like to start out with my own definition of volatility and then throw out some thought starters.

Definition: Volatility is a measure of the degree of change in the price of a security

There are a number of ways to think about changes in the price of a security. For instance, changes in price may be described in terms of:

  • magnitude (amplitude) – how far?
  • frequency – how often?
  • duration – how long?
  • trend – unidirectional or choppy?
  • direction – up or down?

In terms of measurement, common ways to measure price changes include:

  • close to close
  • open to close (intra-bar; excludes gaps)
  • bar to bar maximum (e.g. Average True Range)

Of course each investor has their preferred unit of time, with each bar representing a minute, five minutes, one day or whatever.

By convention, most investors think of volatility in terms of changes in price, but I submit that volatility be measured in the following units:

  • points
  • percentage (of price)
  • standard deviations

Looking back at the definition, I sometimes like to think of volatility more broadly than I have formally defined it. Consider that volatility can be defined in terms of:

  • price
  • volume
  • trend (degree of trending vs. choppiness)

Finally, consider that once measured, volatility can be compared to a number of possible benchmarks. These include:

  • external aggregate (broad index)
  • relative to peers (sector index, sector ETF, other representative ETF)
  • relative to self (including historical volatility and prior implied volatility levels)

I will touch upon all these subjects and more in the coming days and weeks.

Tuesday, February 10, 2009

Some Early Thoughts on the Performance of VXX, the VIX Short-Term ETN

VXX, the iPath S&P 500 VIX Short-Term Futures (1 month) ETN, has now been traded for all of eight sessions. No one in their right mind would attempt to draw some conclusions on so little data, would they? Well, right-minded or not, I am always up for a challenge.

In no particular order, here are some factoids from those first eight sessions with the new VIX ETN:

  • in eight days, VXX has averaged 204,751 shares (for comparison purposes, FAS, which traded 160 million shares today, averaged 127,851 shares in its first eight days)

  • for seven of the eight days, VXX has moved in the same direction as the VIX (on Monday, 2/2, VXX fell while the VIX rose)

  • on three of the eight days (Thursday through yesterday), VXX has registered a larger move in percentage terms than the VIX

  • on average (mean, median, etc.) VXX has been moving at a rate of about 85% of the VIX

  • the average intraday range for VXX is (4.51%), with a maximum of 6.93% today and a minimum of 2.51% yesterday

  • so far the ratio of the VIX to VXX has hovered around .439

Post-Geithner Financial Naked Calls

For the extremely aggressive (and well-capitalized) investor who believes volatility in financials is on the high side and may also have some bullish directional bias, something like a bear call spread with FAZ, the -3x financial ETF, might be an interesting trade to look at.

The truly fearless might even look at selling an out of the money FAZ naked call. As I write this, FAZ is trading with a 48 handle and a Feb 50 call sale will bring 7.20, which means there is room for almost 20% upside movement in the ETF before the trade turns unprofitable. Of course, with the likes of triple ETFs FAZ and FAS, 20% moves can happen in a matter of hours…

[source: optionsXpress]

Pre-Geithner Financial Butterflies

At this stage of the game, it is difficult to predict whether the markets will sell on the news following Geithner’s speech or rally on the possibility of progress.

One thing is much more likely: uncertainty and volatility associated with financial stocks is likely to drop significantly.

There are a number of ways to play the financial volatility game. A basic one is with a long butterfly spread, such as the one shown below, in which XLF is profitable if it stays in a 9.28 – 10.72 range in the next 1 ½ weeks.

[source: optionsXpress]

Monday, February 9, 2009

Marty Chenard and the VIX RSI (30) [REVISED]

For those interested in charting and technical analysis, Marty Chenard of has an excellent stable of charts that he uses as a jumping off point to analyze the markets. Every trading day he has a new free chart and once a week or so he manages to work the VIX and volatility into the conversation.

Unfortunately, at least for the non-subscriber, Chenard’s charts scroll off each week as they are replaced by new ones, but Headline Charts recently captured one of Chenard’s VIX ideas in a post. Headline Charts maintains that according to Chenard, markets do not advance on the basis of a declining VIX alone, but also require that the declining VIX transpire in the context of a VIX with an RSI (30) above the 50 line.

In the six month chart provided by Headline Charts, one can see that the VIX has spent very little time above the 50 line for the RSI (30) during the course of the past six months? Could this be part of the reason why the markets have had such difficulty putting together a convincing rally?

In the chart below, I go back to 2003 to take a longer view of Chenard’s VIX RSI theory. Without crunching any numbers, visual inspection already has me skeptical about the advisability of waiting for a declining VIX with an RSI above 50. I have highlighted four significant bull moves in which there was a declining VIX and an RSI (30) below 50.

I will subject the VIX RSI theory to some further testing, but at first blush I have difficulty finding support for Chenard’s VIX RSI market timing approach.

[I have decided to leave the original post up, but have added the following comments.]

Thanks to Quantifiable Edges for giving my reading comprehension a nudge and for giving me an opportunity to have my own Emily Litella moment. In rereading the Headline Charts piece, I am now persuaded that Chenard was talking about the RSI (30) of the SPX instead of the VIX. This makes a lot more sense to me and shows much more favorably on the charts. Here is a similar chart to the one above, with the RSI (30) for the SPX instead of the VIX. Now I like his theory a lot better…

[graphics: StockCharts]

Saturday, February 7, 2009

Chart of the Week: SPX Price by Volume

There are many methods that technicians use to help determine when various market moves may run into significant support and resistance. Moving averages are one common method, pivot points are another, and Fibonacci retracement levels are one of my personal favorites.

Another method of gauging support and resistance involves the use of charting price by volume. As I have lately heard very little about price by volume charts, this seems like a good time to make these charts the subject of this week’s chart of the week.

In the graphic below, in addition to the standard daily volume vertical bars at the bottom, I have used one of the StockCharts tools to plot horizontal bars that represent the total volume for all the days in which the closing price fell in the range described by each horizontal price by volume bar. The longer the bars, the more volume that was transacted within that price range. For more detailed analysis, I have also color coded the price by volume bars so that total volume for each price by volume range can be further decomposed into up volume (gray) and down volume (red).

In terms of time frame, I have used SPX data from the beginning of October 2008, when the SPX first dipped below 1000, to illustrate possible resistance. Note that during this 18 week period, a large portion of the volume fell in the range of approximately 820-920.

With the SPX currently just one point below its 50 day simple moving average (dotted red line), additional upside movement may be harder to come by. According to price by volume charts, however, the biggest resistance should be in the 890-920 area, where not only is the volume by price bar a long one, it is also predominantly red from previous selling pressure.

If the SPX can clear 920, then resistance (as indicated by the length of the bar and also the ratio of red to gray area) seems to fall off dramatically, with 955 looking like a much less formidable hurdle on the road back to 1000.

Of course the charts have no idea what Geithner is going to say on Monday, nor how the House and Senate will resolve their different perspectives on what needs to be included in the economic stimulus package.

[source: StockCharts]

Friday, February 6, 2009

Condor Options Looks at Volatility Forecasting

Volatility forecasting is a subject that I spend a lot of time with behind the scenes, yet rarely post about on the blog. Part of the reason for my reticence to post on the subject is that my own efforts to develop a volatility forecasting model have demonstrated that whatever proficiency I am developing seems to be limited to at most a 2-3 week forecasting period.

That being said, whenever I see Condor Options write about a subject that I have an interest in (which is almost every time something appears on their site), I take notice. Today my avian friends are tackling Forecasting S&P 500 Volatility, using a variety of approaches, including SPX implied volatility, VIX futures and a trio of GARCH(1,1) forecasting models. The consensus? None, really. The SPX IV data anticipates the most volatile future, while the GARCH(1,1) models see volatility dropping off more rapidly. Check out the full article for the details.

My forecast? Partly cloudy, with a chance of gradually diminishing volatility over the course of the next 2-3 weeks.

Thursday, February 5, 2009

Historical Volatility Dropping Below VIX Again

One of the better tools for determining whether the VIX may be too high or too low is to compare the VIX to recent historical volatility levels in the S&P 500 index. Unlike the VIX, which is measured in calendar days, historical volatility is measured in trading days, so 21 days of historical volatility has about the same time horizon as the 30 days used in VIX calculations.

Instead of 21 day historical volatility, most practitioners seem to have standardized on 20 day historical volatility as the appropriate recent look back period. In order to get a preview of how the 20 day HV is developing, I spend a fair amount of time looking at 10 day historical volatility.

The chart below shows the SPX, the VIX, and 10 day historical volatility in the SPX going back to the beginning of November, just prior to the SPX bottom and the last big VIX spike. Note that since mid-December the VIX has been above the 10 day HV for all but five days, the period stretching from January 28th to February 2nd. With the relatively gentle movement in the SPX over the course of the past few days, the SPX 10 day HV has once again moved dramatically below the VIX, closing at 31.13 yesterday.

Unless volatility picks up dramatically, I would expect to see the VIX start moving in the direction of the SPX 10 day HV, quite possibly returning to the 30s for an extended stay, starting as early as next week.

[source: VIX and More]

Wednesday, February 4, 2009

Why Is There So Little Volume in the Most Recent Direxion ETFs?

It seems as if every day trader I know has fallen under the spell of the leveraged firepower of the Direxion triple ETFs. Oddly, only the first batch of ETFs that were rolled out in November have caught fire. These include the familiar tickers like FAS, FAZ, TNA, TZA, BGU, BGZ, ERX and ERY.

The most recent group of ETFs, which I discussed in Direxion Triple ETFs Add New Horses to Stable, has attracted considerably less interest. Even though they were launched at the end of December, only two of the six ETFs, EDC and TYH, have surpassed the 100,000 single day volume mark and TYH just grazed that bar, with a high volume mark of 101,900. In the chart below, a snapshot taken just past the halfway point of today’s session, the six new ETFs can be seen floundering at the bottom.

Juice is not the problem, as emerging markets (EDC and EDZ) and technology (TYH and TYP) are consistently among the most volatile corners of the market.

The comments on yesterday’s semi-rhetorical question we excellent. Let’s see what sort of explanation the collective wisdom can come up with today.

[source: Yahoo]

Tuesday, February 3, 2009

When the Banks and the SPX Diverge, What Should the VIX Do?

A simple rhetorical question: what should the VIX be tracking, the SPX or the banks?

I raise this issue because for most of today’s session, the S&P 500 index was flattish, while the VIX was down several percentage points. At the same time the financials in general and the banks in particular were struggling mightily. As the chart below shows BKX, the Keefe, Bruyette & Woods banking index, which spent the bulk of the day down 6-8%.

Does the fact that the VIX fell 5.4% while the banks sold off (-5.6%) and the SPX rose (1.6%) mean that traders of SPX options are not concerned about the future of the banks? I find this hard to believe. I would love to hear some comments on this one?

[source: BigCharts]

SPX Symmetrical Triangle Pattern Approaching Breakout

In the chart below, I show a symmetrical triangle (dotted green line) that has formed in the S&P 500 index over the course of the past 2-3 months. As the triangle narrows, the potential for a breakout move – in either direction – increases substantially.

Classical technical analysis categorizes symmetrical triangles as continuation patterns, which suggests that the most likely direction of the breakout move is down. With the SPX currently hugging the bottom of the pattern and needing to gain about 1.7 points each day just to stay above the line, treading water is not good enough. Instead, the markets will need a significant bounce to get some breathing room.

I still think a significant bounce is a strong possibility, but time is running low…

[source: StockCharts]

Monday, February 2, 2009

VXX Volume Easily Surpasses Friday’s Mark

If Friday was an “unqualified success” for VXX, the iPath S&P 500 VIX Short-Term Futures (1 month) ETN, then today has to be considered even more of the same. The new VIX ETN has already exceeded Friday’s impressive first day volume total, with 220,517 shares traded at after 1:15 p.m. ET, with two and three quarter hours of trading still to come.

For the most part the bid-ask spread for VXX has been in the 0.02 to 0.18 range, sometimes higher and sometimes lower. I consider this acceptable for short-term trading of a security priced in the vicinity of 100. Market depth is difficult to gauge at this stage but may be a little on the thin side. As news of the success of VXX spreads, however, I expect liquidity issues to be resolved fairly quickly.

As was the case on Friday, volume in for VXZ, the iPath S&P 500 VIX Mid-Term Futures (5 month) ETN is running at about one third the rate of its near-term sibling.

Bullish Signal from Global Volatility Index

VIX and More’s proprietary Global Volatility Index has been a big hit since I unveiled it in November, which means that I will periodically update it and flag interesting developments in this space going forward.

At the close of Friday’s session, the difference between the Global Volatility Index and the VIX had narrowed to its lowest level since October and the premium percentage (the GVI divided by the VIX) was at its second lowest level ever. I consider this to be a bullish signal.

In the chart below, I have marked the previous highs and lows in the premium percentage with red and green arrows. The red arrow marking the high comes from the first week in December 2007 and was an excellent opportunity to sell or get short. The green arrow from late October was an early bottom. In the months that have followed, the Dow Jones World Stock Index has largely marked time. While this indicator is still relatively young and untested, I consider Friday’s second lowest reading to reinforce or confirm the October buy signal.

As always, caveat emptor.

[source: VIX and More]

Sunday, February 1, 2009

Historical Options Data

Lately I have received several requests to help identify sources of historical options data. First keep in mind that online brokers specializing in options (such as thinkorswim and optionsXpress) often make a surprising amount of options data available to account holders.

That being said, the two data providers that I most often find myself recommending are (in alphabetical order):


  • Market Data Express – a sponsor of VIX and More that is currently offering free registration for those who click on the “Get More Data” button in the advertisement at the upper right hand corner of the blog

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